Page 11 - Repeal of the TEFRA Entity Level Audit Rules Under the Bipartisan Budget Act of 2015

returns for the reviewed years are being filed that there are issues that the IRS may challenge? Should a reserve be established at the partnership level for such potential imputed underpayments?
Consider the enhanced due diligence that a purchaser or even a donee of a partnership interest will want to undertake in purchasing or receiving a partnership. The same holds true for transfers of partnership interests inci- dent to divorce under Code Sec. 1041. In forming a new partnership, will a majority of partners prefer for the taxes to be paid at the partnership level? Where the partnership adjustment relates to the corrected amount of a distribu- tive share of income, will only that partner or successor in interest to such partner be charged with the obligation to make payment? What happens if the agreement merely selects a partnership representative and is otherwise silent on the resulting impacts of the application of the general rule under Code Sec. 6225 or the alternative payment rule election in Code Sec. 6226? How will capital accounts be charged when imputed underpayments in tax are made by the partnership?
Many questions are raised by the new rules, both as to their application and the impact that they will have on existing and newly formed partnerships. For the uninformed, the problems which will surface will be somewhat of a surprise to partners and their legal counsel when the IRS issues a notice of proposed adjustment. Moreover, when a partner holding a purchased or gifted interest learns that she is now required to pay for prior years’ underpayments in tax by the partners, what will be her reaction? Will she hold her lawyer, accountant or both liable for the “surprise”? What will be the impact of the new rules on the filing of partnership returns on a go-forward basis? Will the partnership take less aggres- sive positions to avoid the application of one or more imputed underpayments?
Effective Date
The repeal of the TEFRA partnership audit rules is ef- fective, in general, for partnership returns filed after December 31, 2017. As mentioned, the repeal of the TEFRA partnership audit rules includes the repeal of the electing large partnership provisions. That means that the current TEFRA rules, regulations and pertinent case law remain in effect until the applicable statutes of limita- tion on assessment in tax, as well as claims for refunds for overpayments in tax (at either the partnership or partner levels) for all prior tax years have expired. Partnerships may, however, elect to apply the new rules with respect to tax years beginning after November 2, 2015. Even in
such instance, the TEFRA rules continue to apply until the applicable sunset date is reached as to all open years.
Early Election-in Notice Issued by the IRS
The IRS recently published temporary and proposed regu- lations46 on electing into the new partnership audit rules by a partnership for tax year beginning after November 2, 2015 (the date of enactment) and before January 1, 2018. The ability to make an “early” election into the new ELA rules is authorized under Act Sec. 1101(g)(4) of the BBA. As previously mentioned, the new ELA rules generally apply for tax years beginning after December 31, 2017.
Where a partnership files an “early, elect-in” election in accordance with the temporary regulations, it is not per- mitted to elect out under the small partnership exception underCodeSec.6221(b)forthatreturn.TemporaryReg. §301.9100-22T(a) further provides that an election made not in accordance with these temporary regulations is not valid, and an election, once made, may only be revoked with consent of the IRS. In some instances the elect-in now election will be treated as invalid where it frustrates the purposes of the BBA.
Conclusion
The common theme of the SELA rules shifts the burden of making payment of additional income tax as a result of an IRS audit from those persons who were partners for the year under audit and received the tax benefit from the tax item or items in issue, to the partnership.
Payment by the partnership for the adjustment year indirectly is borne by the current partners, which set of partners may be different or hold different percentage ownership interests than the set of partners for the re- viewed year or years.
This radical, as well as unprecedented, partnership-level tax assessment approach for prior year tax deficiencies will undoubtedly make purchasers of partnership and LLC member interests more careful before proceeding with the acquisition. Perhaps legal and tax advisors will, in response to the new audit rules for partnership, reevaluate the benefit of using the partnership form in the future when advising clients, particularly when a closely held group of owners would otherwise qualify to elect Subchapter S. On the other hand, other taxpayers may find the new rules favorable by being able to “push out” underpayments to the partners during the reviewed years on questionable or uncertain tax positions reported during such prior years.
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